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06/14/2009

The Fatal Conceit: A Pay "Czar"-Becker

This week the Obama administration, acting through Secretary of the Treasury Geithner, appointed a pay czar to review, reject, and possibly set the pay of companies that received large amounts of federal assistance during the financial crisis. No appeals will be allowed from his decisions. The Czar, Kenneth Feinberg, will have broad authority over compensation for the top executives and 100 top employees at Bank of America, Citigroup, American International Group (AIG), General Motors, and a few other companies that received large federal bailout monies. This is surely one of the more preposterous ideas to come out of Washington.
The title of my post, "The Fatal Conceit", is taken from the title of a book published in 1988 by Friedrich Hayek. In this book Hayek attacks socialists for "the fatal conceit" that government officials can effectively determine prices and production through various forms of central planning without having the incentives and information available to firms in competitive markets. A closely related conceit is behind the belief that someone sitting in Washington can determine the pay to hundreds of executives and other employees.
The social purpose of competition and private enterprise is to provide quick responses to constantly changing market conditions. These responses include determining and changing the salaries, bonuses, and stock options of employees and top executives. Companies get into trouble and even fail when their decisions, including decisions on the quality of employees and their compensation, are less effective than decisions of their competitors.
All the companies that will have the pay of top employees under the control of the Czar compete against companies, both domestic and foreign, that will be free to set the pay of their employees. If these companies offer higher pay than the Czar allows for companies under his jurisdiction-whether this higher pay takes the form of bonuses or other forms, or whether fully justified or not-the controlled companies will lose their best employees to competitors, and they will have trouble attracting employees who are highly capable. The Czar could even be making serious mistakes if he just allowed the pay of companies under his control to match the pay offered by competitors. For it is plausible that companies in hock to the government may have to pay more than competitors to entice capable persons to take on the task of resurrecting these companies. This is especially likely since Congress and the Treasury will be calling them to testify and second-guessing their decisions.
The background of the Czar, Kenneth Feinberg, is not reassuring in these respects. A lawyer, he first worked for the federal government, and then during the past several decades headed a law firm based in Washington. Since he apparently has never been an employee of any company other than the government and Washington law firms, how can this background prepare him to set the pay of large companies, such as AIG or GM, that are in highly competitive industries?
In recent interviews Mr. Feinberg claimed that excessive risk-taking fuelled the crisis, and that this risk-taking also led to excessive compensation. Surely, risk-taking has essentially nothing to do with the problems of GM and Chrysler, two of the companies under his wing. Growing leverage by banks of their limited capital base did contribute to the crisis, and perhaps that also greatly increased the pay of bank executives. However, even if this claim is entirely correct, I do not see how that can help him efficiently determine the pay of the (fortunately) few companies under his jurisdiction when their competitors can set the pay of their employees much more freely.
Defenders of the selection of Mr. Feinberg point to his almost three years spent as a pro bono Special Master of the fund that compensated victims of the 9/11 terrorist attacks. I do not know how well he carried out these duties, but determining compensation of victims is entirely different from what is required to set compensation of executives. As Special Master he had to assess the value of losses due to wrongful deaths and injuries. Although that assessment is not easy- it depends on lost earnings and other aspects of the so-called statistical value of life- it really has little to do with determining employee pay in a few companies engaged in highly competitive and changing industries.
The same fatal conceit behind the setting up of a pay Czar is also responsible for the belief that members of Congress and Washington officials are capable of steering GM and Chrysler toward profitable directions. This is behind the government pressure on these companies to shift toward small fuel-efficient cars, even though GM and Chrysler have been best at producing trucks and larger cars. Perhaps they will be able to make this shift, but it is far more likely that Honda, Kia, Toyota, and other foreign auto manufacturers that have been making small cars for decades will eat their lunch.

Comments

I think many of Mr Becker's concerns are well understood by the Obama administration.

"If these companies offer higher pay than the Czar allows for companies under his jurisdiction... the controlled companies will lose their best employees to competitors, and they will have trouble attracting employees who are highly capable."

Mr Becker's reasoning on this is unassailable, but I think it is a bit behind the winds of change.

The stated goal of the administration is to apply these limits to all publicly traded companies (I believe Mr Posner also takes this in view of the situation is his article). Compensation for for all these entities is then to be placed under review by the SEC, the Fed, the President's Working Group on Financial Markets.

This will, no doubt, have some similar effect of flight and disturbance of competition, but between firms in curtailing of new public offerings, and may lead some companies to return to private hands. I am certain, however, that a large number of firms will be unable to extract and exempt themselves, either through the complexity of their existing arrangements or through additional law that would see delisting--or perhaps even refraining from going public--as a regulatory dodge.

The goal of the administration is clearly to establish equal footing -- everyone's throat beneath their heel.

I hate too say this, but most of Hayek's work also suffers from a "Fatal Conceit". That is, that Markets and assorted Corporate Executives and Boards are any better at establishing "Prices and Wages" and not too mention Economic Sytems that operate in the Public Interest than is the Government or it's various Agencies. The now classic example is the current Depression.

As old A.Lincoln once said, "It's time to think anew and act anew". Not too mention, canning the various Econ. Dept's around the globe.

Yikes! One hates to denounce the writings of prize winning economists as obtuse and outdated crapola but it's also hard to find reason for a higher grade.

These apologists for what the very recent "status quo" has become seem to have "forgotten??" what has happened to wage distribution over the last 30 years with increases at very top doubling and tripling, while median wages and those just above and below median have been virtually flat. The min wage has been allowed to erode to barely half the purchasing power it had in 1980 and those folks have not seen a dime of the doubling of productivity over those years.

Today, it's pure and very simple economics that the US and indeed the world is demand starved and the economy simply will NOT work with such a percentage of both wages and wealth being held by a small percentage while the remaining 80% are strapped and have literally no discretionary income after paying basic living costs.

As for trying to foil us with some phony "supply and demand" shuck and jive as companies "compete" for "talented" CEO's and other top excs, how naive do these guys think we are? We KNOW well and have long known that the game is that of the CEO appointing the board and the board appointing a "salary commission" made up of cooperative pals, or worse, those whose own companies will be awarded sweetheart contracts.

In 1980 Ceo's in the US earned about 60 times worker pay, and THAT ration was among the highest in the developed world. Volvo was built on a concept of factor of 10 being the difference between the top earner and the least. Yes, there is a reason for the name "company" and it used to mean a group of people working together to pool talents and labor and achieve more for all than could be done working individually.

Today CEO pay has risen to 400 times worker pay, so the rather annoying term "He works FOR me" rather than "He works with us....... or out team" has never been truer. And has this outlandish scheme of husbanding most of the profits at the top bought us excellence? or even competence? And would not ONE measure of such excellence or competence BE increasing rewards at all levels of pay as productivity increases?

So now that things HAVE gotten so out of kilter "we" circle the wagons and claim that any disruption of what has been previously stolen by Congressional negligence of, at LEAST, increasing the min wage with inflation, killing the unions and collective bargaining, and I suppose buying a batch of radio stations with propagandists that convey to their sheep-like audience the message that they are NOT worthy even of what they do get and are lucky beyond belief that these grossly overpaid CEO's who've stolen complete control of the company will "give them a job??"

Obama might fail in his endeavor to rationalize at least a bit of our wage structure, as JFK once failed in his to jawbone down soaring and inflationary steel prices, but! if this economy is ever to return to any semblance of health, by one means or another, those of the middle income group and those below MUST have a buck in their pocket to spend. The few at the top can not consume that many homes, cars, appliances and other consumer goods we still mfg here. If the US mass market isn't buying China, India and the rest will have increasing problems with the entire world's economy will continue in the death spiral it's in today.

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Lastly, I've not heard much about pressure on GM to build smaller and more efficient cars and their (approved?) plan of selling off Saturn and closing Pontiac leaves them with fewer cars of modest size and good mileage. Even the most popular Hummer, the H-3 gets fair mileage for a midsized SUV.

But if there is pressure to bring the plug-in hybrids or other fuel efficient rigs to market, I applaud the effort as "the market" is again flawed in terms of dealing with either "peak oil" or global warming, as the fuel savings to our individual and short-sighted consumers are too little to spur the changes we MUST make as a community and a nation.

Chrysler? with Jeep and a variety of attractive cars including America's most popular convertible, and its popular Dodge Caravans which still dominate the minivan market, along with Dodge trucks should do just fine after healing up from the financial raping it took from DCX and the thieves of the three headed dog at the gates of hell. Adding some sexy Alfas, as well as some efficient diesel cars to the mix won't hurt either. And, Hey! what could inspire the working folk of the UAW who've given up pay and benefits BUT to see the boys at the top pitching in for the benefit of the team as well?

I am a capitalist for sure. But I guess that once the government was to bail out the perps who crashed my beloved capitalist system, doesn't that give gov the impetous to control the pay that will go to the likes of Ken Lewis? Whom, one has to wonder why he still has his job? I am not advocating gov should determine pay and I certainly agree that "free" markets should dictate prices and pay. But come on boys, free market left years ago. Now we have Wall Street and Congress decide prices and their own salaries.

You assume the highest pay will secure the best leadership for these companies. The events of the past year do not seem to support this thesis. Also, the intangible rewards and notoriety of turning one of these failed behemoths around might be worth a lot and also be quite enticing to a gifted corporate manager.

You also give no weight to the public's (and their elected representatives') likely response to a continuation of compensation packages that are unmoored from reality and incentives that favor short-term gain over long-term properity. If any of these bailout babies need to feed at the public trough in the future, these sorts of pay controls will improve their chances.

I still love capitalism but I've come to distrust capitalists. I don't have much more faith in our politicos, and this move smells of political grandstanding, but I'm willing to go along with it for now.

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I'm quite opposed to government intervention in private markets, including employment markets. It will inevitably lead to even more perverse incentives, inefficiency, and cronism. Nonetheless, if one assumes that the Czar will only have authority over firms that have sought and received Federal assistance, that Czar would create substantial disincentives to seeking government assistance. That's a good thing. It's so good, I would actually favor the Czar having authority over execuive pay for any company that accepts government subsidies of any kind (yes you Big Agri, Boeing, Xerox, IBM, Motorola, Dow Chemical, and GE). I'm pretty sure corporate subsidies would go to zero shortly thereafter.

Look at the Chrysler deal. Obama squeezed out creditors (a teacher's retirement fund for crying out loud...!) to prop up his largest campaign donor, the United Auto Workers union. I'm not sure Hugo Chavez would even make such an egregious intervention like that.

Becker, your logic here is assailable on many fronts. As some have pointed out, the idea that these companies are better able to create compensation systems is ludicrous. As Alan Greenspan said recently, "I was mistaken in the assumption that these banks would be run to ensure their long-term viability and growth." It's clear that they were not. The blind belief that markets find levels that maximize stakeholders' expected returns ignores the idea that some stakeholders are now more important that others. The severe misalignment between underinformed minority shareholders and insider management has reached a crisis level. To leave their compensation systems intact would be negligence of fiduciary duty given the overwhelming evidence we have recently received.
More fundamentally, I would encourage you to consider that markets break down when certain players have undue advantages and when this happens intervention is required. Our current market systems are tilted towards the powerful which will only result in continuing consolidation of assets in the hands of a few. This playing field needs to be rectified in order maximize our entire society's well-being. Any thoughts to the otherwise is just cruel because it disregards increasing pain and misery to the disadvantaged.

1990s B&J policy capped CEO pay at 7x the lowest salary in the company. When Ben Cohen left, the company nearly went out of business because from hiring poor executives at uncompetitive pay. B&J eventually had to scrap the policy to hire a turn-around specialist.

An interesting point that the Pay Czar may drive targeted companies to return to private ownership as quickly as possible. Where the influence will be perverse is with companies like GM where a number of factors suggest there is little or no prospect of it returning to fiscal viability and thus no prospect of it escaping from the public dole.

My first impression is that micromanaging is ineffective role for the Federal Government, and that my teenage years recall the efforts of President Nixon and his Wage Price Control efforts that seem to cause a temporary solution with much bigger long-term economic consequences.
Clearly some pressure needs to be used to encourage better compensation towards a balance of long-term consideration along with short-term opportunities. That the shareholders clearly need more transparency and understanding of how these compensation packages will effect their investments, and a means be found that allows them to better influence corrections when they are slipped into the CEO pay package.
Since at this time the Federal government does play a role as a shareholder, along with structuring means of transparency, and regulation, it can provide a role in identifying what effective means can be established so that shareholders to have some real decision-making voting ability towards monitoring and approving a CEO pay package that maintains a balanced approach towards long-term and short-term opportunities for the company, corporation, business.

I would like to suggest topic of interest to me, on and off for 30+ years. It started in 1973 during my experiences in the Air Force during and after the Yom Kipper war regarding the national security and economic needs for this nation regarding oil and energy. Two general principles struck me deeply, that our need for oil could led to military actions by the U.S. in the Persian Gulf, and that like the depression era Civilian Conservation Corps the U.S. would need to consider the establishment of a decentralized, nation-wide Youth Energy Conservation (Efficiency) Corps.

Shortly after moving to San Jose CA, I learned of Congressman Paul N (Pete) McCloskey‚Äôs bill in the House of Representatives to replace the Selective Service System with a voluntary National Youth Service System. The core principles of change were to have males and females register at 17 encouraged to debate the role of service both in a community format of service and military service. At 18 provide feedback towards yes, no, or maybe towards some form of contracted service. Maybe allowing for further consideration, maturity, additional education for post higher Ed participation. Community service would be vastly expanded with some programs being established by local government, state and federal agencies, but a even higher percentage of focus would be on non-profit maintained programs.

I have gotten brief kind words from members of Congress, including extensive correspondence with my representative then, Congressman Mineta, and Congressman Panetta. Nearly every White House administration, especially the Reagan Administration, but not the current Obama Administration, yet has provided thank you notes. Since 9/11 I have gotten brief encounters with many people of influence, photos to document close encounters, but near zero feedback, at the Commonwealth Club of California, World Affairs Council of Northern CA, Marines' Memorial Association ‚Äì San Francisco, U.C. Berkeley. Not sure why silence is the best these encounters offer, and how capitalism can offer a foolish veteran, career clinical laboratory technician, the means to market participatory democracy constructive citizenship, contracted service as a national product worth purchasing or at least investing in.

Being a fan of Charlie Rose these last 15 years, I discovered Mr. Posner‚Äôs presentation very compelling, worth further exploration, have order a few of his past books, and current one for further understanding of his perspective on life, society, civilization. Charlie Rose is a part of my close encounters, shared detailed documents, wall of silence.

I hope both you Mr. Becker and Mr. Posner can consider this three-part theme of mine:
Educational (decision-making) Democracy
Constructive (sweat-equity) Citizenship
National (economic-individual) Security

I like to think of myself as a existential phenomenologist, trying to understand the reality of what challenges and solutions lie ahead for our nation first, government and capitalism second, political parties a distant third. Having worked in the health care field most of my life, this life game of who lives or dies seems very real, but finding solutions towards a better more effective structure is so complex with winners and losers that our narrow minded ego‚Äôs will probably prevent us from outlining, and creating any real reform that is cost-effective. I look forward to your discussions on this and many other topics.

I hope my priority can become a part of your priorities, at least as a interesting intellectual consideration.

I wonder though, why you think that because a firm is owned and has its pay set by the government that there would be no talented people who would take the job? The assumption is that there is not a Barack Obama out there, coming out of graduate school, filled with a desire to "be of some use" and work for "change [they] can believe in". All of this assumes, incorrectly, that people will always maximize their self-interest.

Anon 12:57 Ha! And we get the President, the VP, the Speaker of the House, the President of the Senate, the Joint Chiefs of Staff and a stretch limo full of top generals, all for far less than a Blue Cross CEO.

Other than leading the charge for ever more vigorous lobbying, and passing on higher costs, or raising prices, do we think we've seen any innovation or rare talent in such offices during any recent decade?

You can't really set pay caps. It kind of goes against our collective American grain. I know we look at executive compensation and are outraged that they make millions even as their companies are failing, but if we start legislating how much people are allowed to earn in a given post, isn't that heading towards socialism at the very least? That's not what America is about, is it?